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Written by: Nick Gartside , International CIO of Global Fixed Income, J.P. Morgan Asset Management
Continued low yields and the risk of rising interest rates mean fixed income investors are continuing to broaden their search for income and total return. But Nick Gartside – International CIO of Global Fixed Income and portfolio manager for the JPMorgan Global Bond Opportunities Fund and the JPMorgan Global Bond Opportunities ETF – believes global bond markets continue to offer plenty of opportunities for flexible, unconstrained investors. Here, he looks at five ideas he and his team believe are attractive for the next 12 months.
1. Still riding high: US high yield
US companies are in good health, and we expect them to remain that way, with higher global growth driving acceleration in earnings. Revenues and debt coverage ratios are picking up, while leverage is ticking down—all good news for bond investors. Default rates, at 1.5% over the 12 months to June 2017, remain well below their long-term average of 3.7%. [1]
Spreads have enjoyed strong tightening momentum for the past 18 months, and while we don’t expect this to continue at the same pace, there is still room for them to come in further in a gradually rising or stable interest rate environment. On the technical front, we aren’t seeing companies being too aggressive in issuing debt, and proceeds are largely being used for refinancing at lower interest rates.
2. Credit where it’s due: US investment grade credit
The strength of the US corporate sector means we’re also positive on US investment grade credit. At above 3%, [2] yields are attractive relative to similarly-rated sovereigns.
This is also a strong demand story: flows into US investment grade credit are the highest in eight years, with demand coming from both domestic retail investors and overseas institutions. We expect lower supply in 2017 as a whole to support the technical picture, though this hasn’t fully materialized yet, as companies appear to have been frontloading issuance given expectations of further interest rate hikes.
3. Banking on banks: European subordinated bank capital
European banks continue to build up their capital buffers, with core equity Tier 1 capital and leverage ratios now well above regulatory minimums. [3] Banks had suffered from fears of even lower interest rates—which would add to the pressure on earnings—but these worries have receded, and earnings revisions in the sector have been positive so far this year. With spreads at around 400 basis points, [4] valuations are attractive on an absolute basis, while issuance levels are manageable.
However, this is an area of the market where it’s vital to be selective. Some banks, particularly in the peripheral eurozone, still have issues with non-performing loans, so it’s important to look closely at the fundamentals of individual issuers.
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4. Going local: Local currency emerging market debt
Emerging markets are benefiting from supportive conditions in the developed world, including still-benign monetary policy and muted US dollar strength. Meanwhile, emerging market fundamentals are also improving, with growth trending higher, debt low relative to GDP, current account balances improving and larger reserve balances providing a cushion against future shocks.
Emerging market local currency debt is arguably the fixed income sector offering the most value at present. Yields have come down, but still look attractive, and currencies are cheap relative to historical averages—hence our preference for unhedged local bond exposure (which does mean we need to keep a close eye on FX volatility). The broad emerging market debt sector has been supported by strong inflows this year, but local currency positioning is still not overstretched.
5. Steering clear: Short European government bonds
Although European government bonds are currently supported by central bank buying, we are wary of the sector. While inflation in the eurozone is low enough to keep the European Central Bank from tapering its quantitative easing program too aggressively, it is still well above bond yields, at over 1% vs. yields close to zero, [5] meaning investors are locking in losses in real terms.
Yields are also unattractive in absolute terms, with the 10-year German Bund at 0.5%5 and approximately 35% of the regional market still in negative yield territory. [6]
Broaden the borders of your bond portfolio
Gain unconstrained access to the opportunities in bond markets around the world with the JPMorgan Global Bond Opportunities Fund or ETF, which seek to enhance total returns by providing flexible, high-conviction exposure across more than 15 fixed income sectors and 50 countries.
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This document is a general communication being provided for informational purposes only. It is educational in nature and not designed to be a recommendation for any specific investment product, strategy, plan feature or other purpose. Any examples used are generic, hypothetical and for illustration purposes only. Prior to making any investment or financial decisions, an investor should seek individualized advice from a personal financial, legal, tax and other professional advisors that take into account all of the particular facts and circumstances of an investor’s own situation.
[1]Source: J.P. Morgan Asset Management, Moody’s Investor Services; data as of 6/30/17.
[2]Source: Barclays Live; data as of 6/30/17.
[3]Source: Company data, J.P. Morgan Asset Management; data as of 3/31/17.
[4]Source: Bloomberg, Bank of America Merrill Lynch; data as of 6/30/17.
[5]Source: Bloomberg; data as of 6/30/17.
[6]Source: Bank of America Merrill Lynch; data as of 6/30/17.